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Why The IMF Is So Worried About The Global Economy

The International Monetary Fund (IMF) now warns that the global economy is entering a critical period in its recovery from the Financial Crisis.

As policymakers shift away from unprecedented accommodative measures, global markets will be left to stand on their own two feet for the first time since before the crisis.

Policy missteps in coming years could trigger a devastating series of economic events that would severely impact global growth.

The IMF has released its new Global Financial Stability report. Here’s a look at what the IMF is watching in global financial markets.

Divergence Between Emerging And Advanced Economies

The first distinction that the IMF draws in its report is the relative strength and stability in advanced economies compared to the elevated risk levels in emerging markets. The IMF believes that the rapid credit creation that many emerging market economies used to weather the Financial Crisis now makes these economies vulnerable to a tightening of global financial conditions.

While developed market banks have spent the years since the crisis increasing balance sheet quality, the IMF notes that banks in China are just now beginning to address "asset quality challenges."

Triad Of Challenges

The IMF sees the following three challenges for policymakers in coming years:

1. China and other emerging markets will be vulnerable as they undergo periods of transition to more consumption-driven economies.

2. In advanced economies, record-high public and private debt level scars from the Financial Crisis remain a big concern.

3. Unprecedented accommodative policies during the recovery from the Financial Crisis have compressed risk premiums in sovereign bonds and corporate credit, as well as liquidity and equity risk premiums. As the Federal Reserve begins its tightening cycle, systemic market liquidity weakness could create turbulence in global markets.

Path To Normalization

According to the IMF, the path to normalization for global markets will be a dangerous one for policymakers. "Without the implementation of policies to ensure successful normalization, potential adverse shocks or policy missteps could trigger an abrupt rise in market risk premiums and a rapid erosion of policy confidence," the report read.

The IMF warns that such a disruption could trigger a series of destructive events in global markets, including capital outflows and higher corporate default rates in emerging markets, risks to European sovereign balance sheets, and the creation of an "adverse feedback loop" that could result in a 2.4 percent contraction of global output by 2017.